Builders Lower Prices To Compete With REOs

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I feel like I just stepped out of a time machine after travelling back to 2003. That was when I first moved to Las Vegas from New York. The real estate market hadn’t reached the bubble phase yet but the market was strong. Entry level new homes were selling for about $90 per square foot with premium homes in the $100-125 range. Resale homes were going for about the same price depending on age and location. The buyer’s choice was to purchase a resale home that was ready now or buy a new home that could be tailored to their individual taste but required a wait of six months or more before it would be completed.

I was one of those who opted for the new home. I purchased it in February of 2003 and it was completed in September of that year. In the time it took for the builder to complete the home, the prices of the same model had increased by about $30,000, or about 8%. That number pleased me because it indicated that the market was appreciating nicely. It turned out that I had bought my home just before the boom took hold.

The Heady Days

From that point on the market seemed to go straight up with no end in sight. Within two years the price of my home had gone up by about 125% based on model match comparable sales. Builders had jacked up the price of new homes to $200-250 per square foot. I was certain that this growth was not sustainable and actually looked to other areas for my real estate investing.

We all know what happened next. People were caught up in the frenzy and used newfangled mortgage loans to buy houses that they couldn’t afford with little or no money down. The bubble burst and Las Vegas became one of the nation’s leaders in foreclosure activity.

What Goes Up Must Come Down

Eventually the market stopped dead in its tracks and the law of supply and demand took hold. Banks were faced with an ever-growing inventory of foreclosed homes, or REOs, and were forced to slash prices in order to sell them. Builders initially held the line on prices but were forced to lower them to avoid holding costs associated with completed homes in their inventory. The local cost to build a basic home is about $100 per square foot and that was thought to be the absolute floor on prices for a new home.

The banks, however, are not concerned with profit. They are already facing huge losses and are just looking to get rid of these REOs. The average price of an REO is about $84 per square foot and that put the builders at a severe disadvantage. At those prices they are not able to compete, are they?

Builders Fight Back

Builders are not starting any new projects but have quite a few developments in progress. Some builders have pulled out of this market or shut projects down until conditions change in a way which would allow them to compete. Other builders have projects that are too far along to stop or close enough to being sold out that it makes little sense to stop now. What they have done is slash prices in order to compete (article). This is a calculated move on the part of the builders. They have done the math and come to the conclusion that taking a loss on these homes is preferable to the costs associated with keeping these projects open indefinitely.

The buyer is the main beneficiary of this situation. Your choice now is to buy a foreclosure for an average of $84 per square foot and deal with the associated problems. You’ll have repairs to deal with, possible evictions, dead lawns and a host of other problems. Or you can buy a brand new home without those problems at prices as low as $80 per square foot. Builders are offering a host of other incentives as well such as free upgrades, help with closing costs and other perks. Those who are considering a new home purchase should use a buyer’s agent prior to visiting these builders so that you take full advantage of the situation. For the buyer happy days are here again.

If you put the federal government in charge of the Sahara Desert, in 5 years there’d be a shortage of sand. – Milton Friedman (Economist)

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.